Emerging market bond exchange traded funds continue to be a popular choice with investors. They offer portfolio diversification, with the appeal of a fixed income investment.
“Over the years as investors have become more comfortable with emerging-markets bonds, issuers have lengthened the average maturity of their issues to 10-20 years. As interest rates have fallen, these bonds have done very well, but if interest rates rise substantially the long duration of these bonds will likely cause high volatility and negative returns,” Timothy Strauts, analyst, wrote in a recent Morningstar article. [Emerging Market Bond ETFs Outperform]
Government-issued emerging market denominated in U.S. dollars were the first type of this investment available. The iShares JP Morgan USD Emerging Markets Bond (NYSEArca: EMB) and the PowerShares Emerging Markets Debt (NYSEArca: PCY) have about 71% of all assets in this category. Both of these funds are established and have enough assets to remain liquid. [Emerging Market Debt ETFs: High Yields, Risk Balanced Approach]
These funds do not hedge currency risk, which means that the risk is shifted to default risk. Should the issuing country be under inflationary pressure, the U.S. dollar denominated debt could be hard to fulfill, reports Paul Britt for Index Universe. [Five ETFs Hitting 2012 Highs]
Also in this category is the emerging market corporate debt ETF, the WisdomTree Emerging Markets Corporate Bond ETF (NYSEArca: EMCB) which invests in high quality multi-national corporations with good credit ratings. Corporate bonds could be a good option for investors desiring a good yield, lower interest-rate risk, and U.S. dollar exposure, reports Strauts. [Podcast: Emerging Market Bond ETFs]
The largest risk to investing in overseas emerging market debt is the currency exposure. By investing in government debt denominated in U.S. dollars, there is less need for hedging currency risk. Overall, the fact remains that many emerging markets have balance sheets that look much healthier than those of developed counterparts. [ETF Spotlight: Emerging Market Debt]
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own EMB.